“You make most of your money in a bear market, you just don’t realize it at the time.” —Shelby Cullom Davis
Given the recent market volatility driven primarily by the outbreak of COVID-19, I thought I would share my current views.
But first, a word about terminology. COVID-19 (coined, for reasons best known to them, by the World Health Organization) refers to the disease, not the virus. The virus itself is a species of coronavirus very similar to the SARS virus that caused the 2003 epidemic. As far as I know, there is no consensus of opinion on what to call the virus itself.
We’ll begin with the fact that it is extremely difficult for anyone, let alone laypersons like us, to know how serious the COVID-19 disease may become. To suggest the difficulty of dimensionalizing the issue, consider that we would need to know, with at least some degree of certainty a) what the penetration of the disease will be, b) what the case fatality rate and eventual population mortality rate will be, c) what the economic impact will be from morbidity, mortality and from fear itself, and d) what the probability and timing of a cure, effective treatment or vaccine might be.
We could speculate about these issues endlessly, but that’s just the problem—we can’t know. It is this uncertainty that creates fear, it is fear that creates panic, and it is the panic that causes us to take actions that will compromise the economic health of our families for years to come.
As in every difficult market environment in history there are many reasons to imagine that “this time is different,” this time we will enter a depression. After all, stocks were selling at elevated prices before the current market drawdown and therefore they were especially vulnerable to almost any disruption. Oil prices are collapsing. Liquidity is a concern, especially in credit markets. The 10-year Treasury is yielding less than 1 percent. Supply chains all over the world are in tatters.
But, stepping back, I would note that, since the New York Stock Exchange was founded under a buttonwood tree in 1792, it has always been the case that the wisest move was to remain invested.
People sometimes point out that, during the Great Depression, it took 25 years for the stock market to reach its 1929 peak. True enough, but with dividends reinvested, as happens with most people’s portfolios, the entire loss was recouped in seven years. And if your time horizon is less than seven years, you shouldn’t own equities at all.
Along these lines I would also note:
During the Spanish Flu epidemic of 1918–19—probably the market episode most nearly analogous to the current crisis—the U.S. stock markets dropped 40 percent. But within three years of the start of the crisis, markets were already recovering and a 10-year bull market followed.
In the “oil crisis” bear market of 1973–74, stocks declined by 50 percent over two years—but stock dividends rose 17 percent over that period.
In 1987, the Dow dropped 23 percent in one day, terrifying investors, many of whom immediately sold out. But the year 1987 ended with a gain, not a loss.
Following the 9/11 attacks, the Dow dropped 7 percent in one day. But a month later the Dow had recovered all its losses.
During the global financial crisis, markets lost almost 45 percent. But the subsequent decade proved to be the longest and greatest bull market in history.
And keep in mind that the outcome of crises is unpredictable and often positive. Consider the worst catastrophe ever to befall humankind, the Black Death, which in the fourteenth century killed between one-third and two-thirds of everyone in Europe. When the dust had settled the millions of farms across the continent had many fewer workers, wage rates rose strongly, power passed from aristocratic landlords to peasants, and the stage was set for the Renaissance.
Thus, I analyze the issues like this:
First, be sure you have enough high-quality fixed income (money market funds, municipal bonds or treasuries) to cover your spending for three years. Bear markets very rarely last longer than that and a robust bond portfolio will allow you to meet your spending needs without selling beaten-down equities and immortalizing your losses (to say nothing of incurring significant tax costs).
Second, assuming your bond portfolio is in place you should look at your current asset allocation and consider rebalancing. If you are below your equity targets consider buying enough equities to get back at least to your minimum equity target and, even better, to your target allocation.
On the other hand, if you are above your equity targets you might consider selling down to your maximum range to book profits before they (maybe) go away.
Third, there is one trade that you might consider now. Treasury and municipal bond yields have fallen to all-time lows and it seems reasonable to expect that rates will rise once economic conditions normalize. Hence, investors might consider taking profits on highly appreciated bond positions and holding the proceeds in a combination of cash and low volatility diversifying strategies.
These recommendations are based on two assumptions:
First, if you own any significant amount of stocks you are a long-term investor, and therefore what happens in the next quarter or the next year or even the next two years simply doesn’t matter.
Second, owning a diversified portfolio of U.S. stocks means that we own the U.S. economy, the most robust and dynamic economy in the world—indeed, in the history of the world. That economy will have its ups and downs, but over the long term—over a period of time appropriate for owning stocks—it will create wealth for our families. The same is true, to a slightly lesser degree, for other free market economies elsewhere in the world.
We should be worrying a lot more about our fellow citizens, especially older and more vulnerable ones, who are getting sick, and a lot less about our investment portfolios.